Journalist Looks at Financial Bubbles

Sudeep Reddy, deputy global economics editor of The Wall Street Journal, appeared on C-SPAN's Washington Journal and was interviewed by host Pedro Echevarria on the subject of bubbles, which Reddy described as when an asset's price becomes "severely disconnected" from some notion of underlying fundamental value.

An example from the late 1990s was the dot-com bubble, where stocks were bought on the assumption that they could be sold at a higher price to a sucker down the road. After that bubble burst, speculators may have rotated into housing, as prices increased at an unsustainable rate until that bubble burst in 2007.

Asked what to look for as signs that a bubble may be breaking and then recovering, Reddy suggested that a moment of panic occurs when speculators fear that they won't be able to find a buyer at a higher price.

As for recovery, in the case of a true bubble, this can take many years. For example, a tech stock like Apple may languish for years before regaining favor.

As to whether another bubble might be forming in housing, Reddy acknowledged the possibility, but he observed that the economy is not looking better for most people.

Reddy added that housing is benefiting from cheap money due to Federal Reserve policy, and the Fed is supposed to monitor the economy for signs of bubbles. However, if bubbles are found, it is difficult to figure out what to do.

Options include regulation and using the so-called "bully pulpit," as former Fed Chairman Alan Greenspan tried to do when he warned of "irrational exuberance." (This writer would note that Greenspan also delivered optimistic messages that could have fueled the bubble, and the financial press helped by lionizing him as the "maestro" of the economy. Also, the Fed notoriously refused for 14 years to use its authority to stop financial institutions from making mortgages without underwriting them.)

According to Reddy, a progression of bubbles may be observed, so that after housing, it was back to tech stocks, perhaps Bitcoin, modern art and rare scotch. Echevarria asked whether the $17.5 trillion dollar debt might be a bubble. Reddy responded that this is "probably a stretch," in light of the standing the debt enjoys as a "fundamental underpinning" of the world economy when investors seek "safe" assets.

In conceiving this article, this writer was eager to learn whether the participants in the program would bring up the role of the Fed itself in fostering bubbles. It didn't take long. The very first caller, a Democrat calling from New York, asked about the Treasury market and the role of the Fed in re-inflating the economy.

It is this writer's view that the Treasury and Fed decided to re-create the bubble in an effort to restore confidence in the economy and themselves. If/when this bubble bursts, they will feel empowered to buy stocks in the name of saving the economy.

For those, including the Fed's minions, who insist that the Fed lacks the authority to buy stocks, they didn't have the authority to bail out Bear Stearns, either. Faced with "exigent circumstances," all bets are off.